Wall Street Can't Agree on Cisco's Prospects

Wall Street is divided on Cisco's (CSCO Quote) prospects. On one side of the argument are two firms that expect the communications technology company to generate a sustainable long-term growth rate of 15% for both the top and bottom lines. On the other are two analysts who see demand for Cisco's products slipping away as economic growth slows at home and abroad.

Although the company does not provide financial updates during the quarter, Cisco itself is remaining optimistic despite deteriorating economic conditions. "While we remain focused on what we can control, as we have said in the past, Cisco is not immune to macroeconomic conditions," company spokesperson Robyn Jenkins Blum said in an emailed statement.

Investors may not find out the true impact of an economic recession on Cisco until it next reports earnings on May 6, but the stock is telling a different story. Since hitting a 52-week high in November, shares of Cisco have dropped 30%. Additionally, Cisco options show that investors are protecting themselves against a possible downturn in the stock. The put-to-call ratio has been creeping higher, indicating that traders expect the stock to decline further.

Cisco isnt alone in this trend. Rivals Nortel (NT Quote), Alcatel-Lucent (ALU Quote), Motorola (MOT Quote) and Tellabs (TLAB Quote) have fallen between 35% and 60% for the year amid weakness in equipment sales. All four of those companies have also had to cut jobs as a cost-saving measure.

History tells us that network stocks could fall even further if we are indeed in a recession. During the last U.S. economic recession, Cisco plummeted roughly 70% from its high in January of 2001 to its nadir in September of that year. Still, the stock performed better than its rivals. During the same period, Sycamore Networks (SCMR Quote) sank 92%, Juniper Networks (JNPR Quote) shed more than 90%, Nortel dropped nearly 88%, Tellabs fell 85%, and the former Lucent Technologies fell about 75%.

"Unlike past downturns, we don't get the sense of a 'bubble' in IT spending, nor a large inventory overhang," says American Technology Research analyst Mark McKechnie. He warns, though, that "Cisco is seen as a global indicator of IT and carrier spending, so it is clearly not immune to macro headwinds."

The Negative Take

On that note, let's take the negative view of Cisco first. During the company's fiscal second-quarter earnings call on Feb. 7, CEO John Chambers cut fiscal third-quarter guidance to 10% growth, down from the 15% growth rate previously expected. While cutting the current quarter's forecast, Chambers did reiterate that the company's long-term annual growth rate will continue to be somewhere in a range of 12% to 17%.

A month later, Chambers reiterated his long-term view at a tech conference, saying that he was even more comfortable with the company's long-term growth estimate. UBS analyst Nikos Theodosopoulos disagrees with Chambers' outlook, saying that the slowing environment prompts him to believe that Cisco's growth target of 12% to 17% may be a little too aggressive.

"Our industry checks show orders are slowing which gives us concern about the July quarter," said Theodosopoulos in a research note. "Recent checks indicate that in addition to prior softness in U.S. enterprise, European enterprise is slowing a bit." He also notes that emerging markets, while still strong, are growing in the 25% to 30% range, not the 30% to 40% target that many expect.

Those comments echo what JPMorgan analyst Ehud Gelblum said after the firm downgraded Cisco's stock to neutral from overweight on April 7. "It appears that Cisco's international and specifically emerging markets exposure is not enough to offset slowing in North American and Europe, making Cisco not the safe place to weather the economic storm we thought," Gelblum said in a note.